Q. and A. With the Fed’s John Williams: Timing of Rate Rise Is Overrated

John Williams, president of the Federal Reserve Bank of San Francisco, says he’s done talking about which month the Fed will start to raise its benchmark interest rate.

“I’ve sworn to myself that from now on the only months of the year I’ll refer to is months that have reference to births and anniversaries,” he said in an interview this week.

But Mr. Williams did offer a specific answer about the timing of that first increase: He will vote to raise rates, he said, when he expects unemployment to fall to its minimum sustainable level within the next year, and inflation to rise to 2 percent within the next two years.

He also offered his thoughts on the great debate between Ben Bernanke and Larry Summers, and the consequences for monetary policy.

The transcript of our conversation was lightly edited for clarity.

Q. Last month you described the economic outlook as “downright good.” Does that remain your view despite the recent run of disappointing data?

A. The underlying momentum is still quite strong. There’s no question that some of the recent spending data and employment data have come in a little weaker than we had been thinking. On spending data, I think some of that is due to the unusual weather. A national shipping company — they’re able to track how much truck shipping is disrupted by weather conditions, and the 2014 winter was the worst on record for them in terms of disruptions and this year was one of the worst, so there’s something real there. Of course last year was negative, and this year the first quarter is going to be positive, around 1 to 1.5 percent. On the employment numbers, I thought those numbers that we had been seeing were extraordinarily strong given what we were seeing on G.D.P. and other signs. So that was the anomaly — why was the employment growth so strong? — and so the revisions to the data don’t worry me really about the underlying trends there.

Q. Do you expect the Fed to start raising interest rates by September?

A. Moving away from the date-based guidance, trying to indicate what we will or will not do, I thought that was a really important step. It gets all of us away from thinking about this meeting vs. that meeting. I may have a view, but in a way it’s irrelevant. As the data come in, whether it’s on the employment mandate or the inflation mandate, I’ll change my views of where we are or where our trajectory is on that. I’ve sworn to myself that from now on the only months of the year I’ll refer to is months that have reference to births and anniversaries.

Q. But you’ve said that you think the Fed should raise rates this year?

A. I do believe that we should be initiating rate increases later this year. I’m still a 2015 person. But I do also think the more important part of this story is not the date of the liftoff but what is the pace of tightening expected to be.

Q. So what does data dependence mean? What do economic conditions need to look like in order for John Williams to be ready to start raising the Fed’s benchmark rate?

A. I would say forecasts that we’re getting back to full employment, broadly defined, within a year’s time, and also to have that view that within two years’ time that we’ll have inflation back to around 2 percent levels.

Q. What gives you confidence inflation will rebound after years of sluggishness?

A. I think the data show that U.S. inflation can be easily modeled in the following way: It runs about 2 percent, and then there is some fluctuation from commodity/import prices and the amount of slack in the labor market. So the fact that core inflation is running around 1.5 percent seems pretty consistent with that view that underlying inflation is running a little soft because the economy hasn’t gotten to full strength, and the strong dollar, so to me it’s not that much of a puzzle that underlying inflation is running about half a percentage point below our 2 percent goal.

Assuming energy prices stabilize and import prices go back to not being as significant a source of downward pressure, and with the growth that I projected and the improvement in the labor market I projected, I expect us to be back at full employment late this year or early next year. And my view based on the evidence of the past several business cycles is that when you push the unemployment rate down, you push the economy to the point where the labor market is stronger than normal, that’s going to create wage pressures in the labor market and be one of the factors that pushes inflation back to 2 percent. I have confidence because that’s what we’ve seen in previous business cycles.

A. The fact that there’s low inflation abroad is an important part of the environment we work in, but I don’t think that speaks in any way to whether the U.S. can hit its 2 percent goal. We know from history that we are able to control our own inflation rate through monetary policy despite other countries having rates that are higher or lower than ours is.

Q. You estimate that the unemployment rate, now 5.5 percent, will settle at about 5.2 percent. That’s a little higher than before the crisis. Why?

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John Williams, president of the Federal Reserve Bank of San Francisco, in 2013. He said that the economy's "underlying momentum is still quite strong."CreditTony Avelar/Bloomberg, via Getty Images

A. My view on the 5.2 is that there’s been a whole evolution over the last few years. The natural rate of unemployment today on demographics alone would be a little lower — a quarter percentage point, say — than in 2007. The other thing is that there were a lot of factors pushing up unemployment during the depths of the recovery. And the third thing is data dependence. Clearly we’re not seeing signs of strong wage growth or other pressures as it comes down to 5.5 percent, so that does suggest we haven’t yet gotten to full employment or past it.

Q. And once you’ve started, the Fed has said that it wants to move gradually. Does that mean about 1 percentage point per year?

A. It’s going to take a few years to get back to a more normal level of interest rates. During the last business cycle, two points a year was seen as being gradual. This time I would say that gradual is relative to that, slower than two percentage points a year.

Q. The minutes of the Fed’s March meeting caused some consternation because you continue to tweak the mechanical details of your plan for raising interest rates.

A. When it comes to contingency planning, I feel like it’s damned if we do and damned if we don’t. We’ve issued a very clear statement of principles, and we’ve now added some details to that around our plans — around the reverse repos and some of the other tools — to provide the best clarity that we can. And part of the discussion gets into contingency planning. And we will clearly be learning how markets behave given that we are in these unusual circumstances. I have a great deal of confidence that the tools we have will allow us to have interest rates move exactly consistently with the directives set by the F.O.M.C.

This is a typical Fed belts-and-suspenders approach. We’re not exactly sure how interest rates will behave and so we want to make sure that we have the full set of tools and programs so that we can make sure we can conduct monetary policy. To my mind it’s a lot of contingency planning and thinking through various options, and that’s what we should be doing. I don’t know why one would be critical of that.

Q. The Fed currently projects that when you finish tightening monetary policy, interest rates will be around 3.75 percent. That’s lower than before the crisis. Does it give you enough room to address the next crisis?

A. We argued in our research before the crisis that 4.5 percent was a sufficient buffer for most cases. If you take 3.75 percent, on that same analysis, it definitely cuts into that buffer quite a bit. And so I do think the zero lower bound issue, by this math, we’re going to be hitting it more often in the future than we thought we would in the past, and not just because of the extraordinary period that we had in the last seven years. And I think the lessons from the last seven years that we’ve learned from our own country and from other countries too are going to be very valuable.

Unconventional monetary policy, which we’ll be leaving as we get back to normal, will be a necessary ingredient at times. And I really think the biggest lesson to me has been the importance of acting quickly both to lower interest rates and also the willingness and ability to step into these unconventional policies. The Fed moved aggressively on Q.E., but our forward guidance took longer to get going, so that’s a lesson we need to remember in the future.

Q. And if Larry Summers is right that interest rates are likely to remain low?

A. It gets back to the question of whether the zero lower bound is going to be consequential in the future. The question is, as we get out of the aftermath of the global financial crisis, are we and other countries going to find ourselves back to what we thought of as a normal situation? One side would say, well, it’s all about headwinds and the aftermath of the crisis. Once we get past all of that, interest rates will get back to normal levels. The other view says there are some fundamental factors and that situation is obviously very worrisome.

If you really think we’re going to have an equilibrium interest rate of 1 percent, operating monetary policy in a normal way will be very problematic. Your buffer goes to 300 or maybe 200 basis points. If you really thought that’s the world we’re in because of the demographics or productivity growth — if that’s really what our future holds — I think that’s just a reality that you need to think about monetary policy and its ability to achieve goals. Is the 2 percent inflation goal sufficiently high in that kind of world? These are the kinds of issues that you have to take seriously if the secular stagnation view is right.

Q. Do we just need to wait five years to find out who is right?

A. The data that we have has made it so that we can make much more rapid progress on key issues. It used to be that we needed time-series econometrics, but today in macroeconomics, it’s all about using micro data on individual households and using that data, hundreds of millions of households, to inform views on different issues. So I don’t know if it will take five or 10 years to get better insights into some of these issues. I do believe that empirical research can give us a much better read on these probabilities in the next few years.

I’m really kind of excited about the research that can be done around these issues. Not just to answer is Larry Summers right or is Ben Bernanke right but to understand how the economy works more generally. There are a lot of fascinating issues about how demographics affect the economy’s development that we haven’t in the past studied so much. Japan always brings this up: that demographics is the most important factor in their macroeconomy. As a U.S. economist, that always seemed like a nuisance parameter and now we are seeing that the demographic wave is so big that it’s an important area to understand how that affects growth and productivity and fiscal issues and even monetary policy. So I think we have a lot to learn about that.

Q. You vote on monetary policy only every third year. Do you think you should have a vote every other year, or every year, as some have proposed?

A. To my mind there is no question that whether you are a voter or a nonvoter doesn’t matter in terms of whether you are able to participate and raise issues. Janet Yellen as president of the San Francisco Fed voted only once every three years, and no one would claim that she didn’t have a voice. What matters more is the issues you raise, the perspectives you bring, the information you bring — are they relevant or interesting? It doesn’t matter whether you’re a voter or nonvoter. I don’t think this is something that’s broken or dysfunctional. There’s an arbitrariness to the voting rules, but that to me is not a problem that needs to be fixed.